There’s a joke that perfectly sums up what small business owners experience when they apply for a loan.
Henry: “Hey Paul, why do you look so dejected today?”
Paul: “Oh Henry, I’m in trouble. I need cash for the business and I have NO IDEA where to get it from.”
Breathing a sigh of relief, Henry responds: “Oh, I’m sure glad to hear that. I was afraid you might think you could borrow it from me!”
The numbers tell the same story. About 80% of small business owners who apply for a bank loan get rejected.
Which is why it will be interesting to see where the recent SMB lending program partnership between Amazon and Bank of America goes. Usually, Amazon entering a new industry gives the competition something to think about. But that may not be the case this time. Here’s why:
#1: Too little, too late
Small businesses and the booming freelance workforce are big drivers of the economy. And when given the runway, they can become the big companies that banks like working with. After all, Bill Gates himself started out in his garage.
But while big banks have been busy denying loans to small businesses and freelancers, small, alternative lenders have made themselves indispensable to the financial community. In the last few years, legitimate alternative lenders have been gaining a foothold in the space and filling the vacuum for small business financing with innovative models.
Platforms like GoFundMe, Qwil, or Africa’s Branch, have quickly grown a customer base and scored significant investments precisely because of the ways they are unlike big banks. GoFundMe has no deadlines or goal requirements, doesn’t care about your credit score, and won’t repossess your car if your business doesn’t take off. It gives aspiring small businesses the chance to tell their stories and connect with people directly —something that’s impossible to do when attempting to secure funds through big banks.
Freelancers and small businesses seeking loans find that the threshold for small dollar credit at a financial institution is quite high, versus what alternative lenders are willing to work with — advances as small as the $20 range. Being able to do that as easily as a $20k bank loan- — and still make a healthy margin — means the freelancer goes home happy, and everyone wins.
#2: Trust Issues
Not unlike what it was at the onset of the Great Depression, consumer confidence in financial giants has been shaky in recent times. Only 32% of respondents in a Gallup poll said they have confidence in financial institutions, with that number falling consistently over the past few years.
The 2008 financial crash demonstrated that not only is no financial institution is too big to fail, but they are also big enough to get away with some seriously customer-unfriendly behavior. Including, of course, Bank of America, which hardly escaped the economic storm, especially with its questionable acquisitions of Countrywide Financials and Merrill Lynch and the ensuing billions paid out in settlements.
As Amazon enters the lending arena, that same distrust in big banks will follow the e-commerce giant. Reports of Amazon’s abusive labor practices and recent reversal on Seattle’s so called “head tax,” designed to tax large companies and use the funds for the city’s growing gentrification-induced homelessness problem, might be cause for concern.
Then there’s customer experience, which has proven to make or break businesses. Given the opportunity, most people would rather not jump through the bureaucratic hoops that financial institutions present — spending hours filling forms and undergoing interviews. Applications for alternative lending platforms tend to be far quicker, easier, and can be completed entirely online.
For example, freelancers we work with can elect to gain access to their earnings ahead of pay cycles within seconds , even if their employers would ordinarily take months to process payments.
Does that mean small businesses will likely think twice before applying for a loan with BoA and Amazon? Probably.
#3: The Cost of a Customer
For most banks, commercial acquisition costs range from $9k to $35k with an average of around $16k (source). The combined overhead of marketing, advertising and sales staff explains both the high cost of customer acquisition for big banks, not to mention higher fees for borrowers.
Some alternative lending models, on the other hand, are lean enough to avoid passing on those overhead fees to their customers. What’s more, rather than depending on significant marketing spendings, alternative lenders can target freelancer ecosystems such as Hired and TriNet, thus growing their market stake exponentially while keeping costs low for the small businesses and freelancers they serve.
While banks may take years to create products for a new client base because of slower movement amidst regulations, lending startups can react to the market immediately. Recently, when it became evident that freelance app developers were also in need of better financial support, we began to advance earnings to them, despite that market pool not existing previously.
The Future of Alternative Lending
With any loan, the underwriting model is worse or better depending on the type of marketplace, and that’s true for any financial institution. One model isn’t always necessarily safer. But the customer acquisition model is where alternative lenders really pick up efficiency. What’s more, a fold will happen sometimes, but it hurts bank profits more than it hurts a small lender’s profits.
As with anything in the world of entrepreneurship, only time will tell if David stands a chance against Goliath. But, if we had to bet, we’d put our money on the little guy.